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From Securities Regulation Daily, September 11, 2017

Fraud allegations re: GNC’s supplement ingredients suffer from deficiencies

By Amy Leisinger, J.D.

The Western District of Pennsylvania has dismissed a securities fraud class action against a provider of health and wellness products and certain executives for failure to plead scienter and loss causation. According to the court, statements by confidential witnesses failed to establish that the company’s executives had knowledge of potentially harmful ingredients in products prior to being specifically informed by the Food and Drug Administration or that any officer engaged in inappropriate trading. In addition, the court found, the complaint failed to sufficiently allege the existence of corrective disclosures that revealed any fraud. The court did, however, grant leave to amend to remedy the deficiencies (Martin v. GNC Holdings, Inc., September 8, 2017, Hornak, M.).

Questionable ingredients and securities fraud. GNC Holdings, Inc. manufactures and merchandises health and wellness products, including its own proprietary products and products purchased from vendors. GNC faced problems in 2011 involving a potentially harmful ingredient called dimethylamylamine, and, in April 2012 (following receipt of a letter from the FDA), the company reformulated products to remove the ingredient. However, the reformulated products purportedly contained other potentially dangerous ingredients, which GNC officials could not confirm had submissions on file with the FDA. In September 2015, an FDA official released a declaration stating that one of the ingredients did not qualify as a "dietary ingredient" (lawful under federal law), just after GNC had ceased selling products containing the ingredient. The other potentially harmful ingredient was the subject of adverse studies and press coverage, and, in April 2015, when the FDA formally announced that it also did not meet the definition of a dietary ingredient, GNC stopped selling products containing it. Shortly thereafter, the Oregon Attorney General filed a civil action against GNC, and the company’s stock price began to fall.

GNC stockholders filed a class action complaint alleging that the company and certain of its directors and officers knowingly or recklessly made false and misleading statements about GNC’s quality controls and product purity and its ability to manage regulatory risk and offset losses sustained in connection with the removal of the ingredients. The defendants moved to dismiss for failure to plead falsity and scienter with the requisite particularity and to cite corrective disclosures to establish loss causation.

No strong inference of scienter. The complaint cites GNC’s "close connection" with vendors to suggest that the defendants would have had access to ingredient information for third-party products, but the confidential witness statements relied on lack specific information about which employees or officials had access and possessed the information that the complaint claims they may have had, the court found. In addition, the allegations that the individual defendants had access to information about product recalls and regulatory concerns lack detail and corroboration, according to the court. The complaint’s attempt to bolster the inference of scienter by relying on the core operations doctrine is also insufficient absent particularized allegations linking the executives’ positions to their knowledge of potential falsity, the court found. Finally, the complaint does not indicate why the timing and nature of stock sales were irregular or how signed certifications support executive knowledge of false statements regarding the ingredients. Even considering these allegations collectively, the inference of scienter is not as strong as an opposing inference of non-fraudulent conduct, the court concluded.

No loss causation. According to the complaint, GNC common stock traded at artificially inflated levels because of the defendants’ alleged material false and misleading statements and omissions, and the price declined when the truth was revealed with "corrective disclosures" in the Oregon Attorney General’s complaint. However, the court determined, that complaint contains only allegations of unproven misconduct and cannot serve as a corrective disclosure. Moreover, GNC’s disclosure of lower earnings without a link between the disclosure and a fraud is not a corrective disclosure, and, as such, the complaint fails to adequately plead loss causation, according to the court.

Puffery and forward looking statements. Statements of opinions, intentions, and optimism would not alter the total mix of relevant information available to investors and constitute no more than puffery, the court noted. The cited statements relating to GNC's quality controls and product purity tout the company as an "industry leader" with "high standards" and a "number one priority" to protect customers merely convey general optimism, the court found. A reasonable investor would not deem these statements important in deciding how to act, the court stated.

While some misstatements characterizing past or present conditions do not qualify as protected forward-looking statements and have been adequately pleaded, they still must fail for lack of scienter and loss causation, the court concluded.

Dismissing the controlling person claims for failure to adequately plead a predicate violation, the court will allow the stockholders to file a motion for leave to amend within 30 days.

The case is No. 2:15-cv-01522.

Attorneys: Gerald L. Rutledge (Law Office of Alfred G. Yates Jr. PC) for James Martin. James L. Rockney (Reed Smith LLP) for GNC Holdings, Inc.

Companies: GNC Holdings, Inc.

MainStory: TopStory FraudManipulation PennsylvaniaNews

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